Even a decade back, nobody could perceive that decentralized digital currencies will rise to a position to threaten the supremacy of fiat currencies but that day is not far! In the last few years, cryptocurrencies have become very popular and people are using these decentralized digital tokens in lieu of typical currencies, more than ever before. The fast-evolving crypto sector has not only become a substitute for making transactions digitally but has also opened a new avenue for investors. The popularity and market share of Bitcoin notwithstanding, newer generation coins aka stable coins have started gaining traction.
What are Stablecoins?
The Stablecoins are designed to address the limitations present in first-generation crypto coins including Bitcoin. The stable coins serve as the digital equivalent of cash and also act as assets with value that does not diminish easily. While they are reliant on Blockchain infrastructure, stable coins are tethered to tangible and external assets, like gold or US dollar, etc. This makes them somewhat immune to the volatility the traditional crypto coins are known for. So, the price of a Stablecoin will not fluctuate as widely as that of Bitcoin, for example. So, in a way, stablecoins get an edge over both cryptocurrencies and fiat money.
Stablecoins not only serve as means of transactions but you can use them for lending purposes too. So, you can use Stablecoins to obtain loans at better rates. Stablecoins can be either decentralized or centralized.
What are the variants?
Stablecoins can be of 4 types. These are:
- Fiat currency-backed stablecoins
- Commodity-backed stablecoins
- Algorithmic (non-collateralized) stablecoins
- Cryptocurrency-backed stablecoins
The Fiat-collateralized stablecoins are quite popular and they rely on a fiat currency type such as the USD for marinating stability of price. The examples are Circle, Tether, Pax Dollar.
The Commodity-backed stablecoins depend on some type of hard assets to offer price stability. These coins rely on assets like silver, gold, or real estate. The value of these assets does not go down easily and so these variants are much in demand.
Cryptocurrency-backed stablecoins are termed over-collateralized. It means the collateral’s worth is more than that of the coin itself. An example is MakerDAO’s DAI which is backed by Ethereum’s own smart contracts.
Non-collateralized stablecoins, also called algorithmic stablecoins, depend on smart contract algorithms to maintain price stability. Examples include Terra (LUNA) and DefiDollar (DUSD).
Pros of stablecoins
- Payment processing gets done way faster, cross-border and anywhere.
- Stablecoins do not have high processing fee by enabling true peer-to-peer transactions.
- Stablecoins are programmable and that opens up avenues for new use cases.
- Stablecoins are inherently secure and stable.
- These coins help bridge the gap existing between cryptocurrency and fiat money.
- Stablecoins can be purchased and sold anytime, unlike the banking system which is affected by server downtime and maintenance issues periodically.
Cons of stablecoins
- The reality is stablecoins offer only relative stability.
- Not all stablecoins are decentralized and those need a third-party operator.
- Stablecoins cope with regulatory scrutiny from central financial institutions and govts.
- Stablecoin exchanges enforce KYC regulations that eliminate anonymity.
- Entities that issue stablecoins often operate without audit and licenses, paving way for risks.
Some governments and regulators are afraid of stablecoins
The advantages offered by Stablecoins are too big to ignore but governments in various countries and major financial regulators are afraid of its adoption. They think its growth can hamper the existing monetary systems powered by mainstream fiat currencies.
Stablecoins got mired in regulatory cobwebs for the first time in 2019. It was when Facebook unveiled its plan for launching Diem (Libra) a stable coin- owned by the hugely popular social media platform. Diem faced brickbats from the U.S. Congress. After some hot debates, Diem is now in the development stage. It will be made available as a Stablecoin pegged to the USD. The strongest objection to the adoption of stablecoins came from the People’s Bank of China.
Reasons why regulators are mostly antagonistic to the concept of Stablecoins
- The 1st reason for objecting to the introduction of Stablecoins is the fear of losing the importance of fiat currencies.
- The stablecoins also have the power to bring an end to the monopoly and control of govts over their national currencies.
- Some stablecoins are decentralized in nature and there remains a risk of money laundering.
What the future looks like for the Stablecoin sector?
Despite the fear nurtured by the regulators and governments in many countries, all is not bleak for the Stablecoin sector, say the crypto sector experts. With time, the governments and regulators may find ways to incorporate stablecoins in the existing financial system. The U.S. lawmakers came up with the STABLE act last year for tying all stablecoins to the dollar. In a similar way, the European Union came up with a unique proposal for stable coin regulation. Things are like a mixed bag in the Asian subcontinent, with China imposing a blanket ban on all cryptocurrencies and the Bank of Thailand offering a framework for stable coin regulation.
The corporate giants are also experimenting with the concept of using stablecoins for enabling smooth and low-cost digital payments. Apart from Facebook, retail giant Walmart is also planning to launch its own stablecoin. The upcoming Walmart Coin is aimed at the low-income group of people for whom banking services are too costly.
However, it would be wrong to think everything is rosy with the Stablecoin sector. A section of financial sector experts believes the upcoming central bank digital currencies may pose steep competition to the stablecoins, threatening their growth. A majority of central banks in the world are now busy developing their versions of CBDCs. The central bank of China is a forerunner with the Digital Yuan in its kitty. It is too early to say if the CBDCs will threaten sustenance of stablecoins or both will co-exist in an evolving digital-centric financial system. It may take a long time before the governments launch the CBDCs and streamline and tweak existing financial networks to accommodate these. Till then, Stablecoins will be used by users seeking a balance of smooth digital transactions and price stability.